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June 4, 2012

Alternatives Growing in Portfolios as Markets Stumble

Nontraditional investments could grow to 10%-15% of mutual funds in 10 years, according to Cerulli

Two separate studies released Friday show that asset managers and advisors are increasingly turning to alternative investments to help clients boost returns while supporting the growth of assets under management.

Boston-based Cerulli says its annual examination of the retail alternatives and ETF marketplaces found that asset managers expect alternative mutual funds to comprise nearly 10% of all mutual funds within five years. Plus, this percentage should jump to more than 15% in 10 years.

In a separate study conducted by Practical Perspectives, a Boston-based consulting and research firm, financial advisors indicated that they expect continued growth in their use of alternatives and nontraditional investments. Most advisors currently allocate up to 15% of a typical client portfolio to these products, which is likely to increase as advisors grow more familiar with their benefits and uses, the report concludes.

"Interestingly, the need to differentiate in a competitive marketplace was the leading driver in 2011, and is considered much less of a driver in today's market,” said Alec Papazian, lead author of the Cerulli report, in a press release. “We attribute this to the fact that so many managers now offer these strategies. 2011 was a record year for alternative mutual fund product development with 95 new funds being launched."

Cerulli's latest research shows that the leading driver behind asset managers' interest in alternatives—nearly 90% of advisors cite it versus fewer than 75% last year—is tied to investors' need to optimize the risk-adjusted performance of their portfolios. Another significant driver, for 72% of advisors surveyed in 2012 versus 60% in 2011, is managers' expectations regarding future capital-markets returns.

The Practical Perspectives study finds that financial advisors can be divided into three core segments based on the likelihood of using alternatives and nontraditional investments for clients: heavily engaged, 30%; moderately engaged, 34%; and minimally engaged, 36%.

The study also concludes that most advisors, 60%, are allocating 10% or less to these products, though advisor use of alternatives and nontraditional strategies has increased notably in the past two years.

“Alternatives and nontraditional investments are increasingly important to advisors in serving retail clients," said Howard Schneider, president of Practical Perspectives and a co-author of the report, in a press release. "This growth has been spurred by the challenging capital markets and the expanded availability of these strategies in mutual fund and ETF formats.”

The firm’s research emphasizes that the desire to enhance diversification and lower portfolio volatility and risk are the main factors driving increased use of alternatives and nontraditional investments. Plus, most advisors use mutual funds or ETFs as the main vehicle for investing in alternative products.

The most important factors in selecting alternatives and nontraditional investments are the expertise of the investment manager and the low correlation relative to more traditional investments.

Education Counts

“The audience for alternatives and nontraditional investments is definitely expanding,” noted Richard Gauger of Practical Perspectives, a co-author, in a statement. “Yet many advisors still lack familiarity with these strategies.”

According to Gauger, advisor satisfaction is lagging “relative to the importance they place on factors such as wholesaler support, product research and due diligence.”

There is a direct correlation between satisfaction with support and advisor use of these strategies, he adds, so “product providers and platforms should be focusing resources more effectively on key audiences.”

For its part, Cerulli says its research shows that distribution access and advisor knowledge are the largest challenges facing alternative managers.

Still, many broker-dealers, in particular the wirehouses, appear very supportive of increasing the use of alternatives among their advisors. On average, wirehouses see allocations at only 4% among their advisor forces but would like this to increase to greater than 15%.

"Firms that are providing superior educational materials may find that this provides an advantage within the wirehouses, which are looking for help in increasing advisor adoption," said Matthew Pickering, a co-author of the recent research, in a statement.

"Most advisors report that asset allocation education on how to incorporate alternatives into portfolios is the most helpful method to increase their adoption of these products. Firms that have a thoughtful approach to educating advisors will see increased flows," Pickering added.

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